US Strategy Weekly: 92% Up Day on Low Volume

The July 19, 2022 trading session was notable, not just for the 754-point gain in the Dow Jones Industrial Average, but because preliminary NYSE data shows that 92% of the day’s total volume was in advancing stocks. We have been waiting for a 90% up day to appear in breadth data which would show that downside risk is minimized. Yet while we are pleased for the near term, we are not impressed for the longer term.

This was the first “90% up-volume day” since the 92% up-volume day recorded on May 13. The May 13 session materialized right after the S&P 500 dropped below the 4000 level, which in our view, was a sign that value was returning once prices fell below the SPX 4000 mark. However, on both May 13 and July 19, total NYSE volume was average, or in the case of July 19, below the 10-day average. This is unfortunate since below-average volume weakens the signal in terms of defining a major bear market low. Nevertheless, the July 19 trading session is important since it denotes a return of buying pressure and it represents another step in the market’s bottoming process. We expect more follow-through to this rebound in prices.

In concert with the 90% up day, all the broad equity indices moved above their 50-day moving averages for the first time since April. It is quite normal for a bear market rebound to retest the 100-day or 200-day moving average. However, the 50-day moving averages have been a ceiling for prices in all the indices since early April. At this juncture, it would be normal for momentum to carry stock prices to at least the 100-day moving average lines. These averages equate to Dow Jones Industrial Average 32,840; S&P 500 4,148; Nasdaq Composite 12,470 and Russell 2000 1,890. See page 9.

Another technical indicator we will focus on in coming weeks is our 25-day up/down volume oscillator. It has amazed us that despite the substantial declines in prices this year, there have been few oversold readings in this indicator. But in the last two weeks the oscillator was oversold in six of eight consecutive trading sessions. The deepest oversold reading was on July 14 at negative 5.17, the most extreme oversold reading since March 27, 2020. At a classic bear market trough pattern, stock prices may fall to a new low in price, but this oscillator will have a less extreme oversold condition. This would be a sign of waning selling pressure and be favorable. So, in coming weeks, a new low, but a less severe oversold reading would be a positive sign.

The Week Ahead

The equity market is way overdue for a rebound; however, there are several land mines in the immediate future. Next week is the July FOMC meeting and there is a vigorous debate about whether the Fed will raise the fed funds rate 75 basis points or 100 basis points. Fed Chair Powell will be announcing the decision on July 27. A rate hike is widely expected; yet history has shown that when the Fed raises interest rates substantially, it increases the value of the dollar. Rising interest rates coupled with a strong dollar can have repercussions on global finances, particularly in subprime credit markets, in ways that are unexpected.

On July 28, the Bureau of Economic Analysis will release its preliminary estimate for second quarter GDP. As we have previously stated, we would not be surprised if it is a weak number, or a negative reading. A negative GDP number could ironically be a major plus for investors since it would confirm a recession — and stock markets tend to bottom in the second half of a recession. In short, the next few days should be interesting.

Inflation, the Fed, and the Consumer

Barring signs of an immediate recession, recent economic releases show the Fed is way behind the curve and has a lot of work ahead of it.

Inflation accelerated in June. Headline CPI rose 9.1% YOY, up from 8.5% in May and core CPI increased 5.9% YOY, in line with the 6% recorded a month earlier. Although the administration and many economists are highlighting the small decline seen in gasoline prices recently, the outlook for inflation is not good for the rest of the year. For example, homeowners’ equivalent rent increased 5.5% in June, up from 5.1% in May. Rent prices are apt to rise further since rents tend to lag the trend in home prices, and home prices are still rising at a double-digit rate. The median price of an existing single-family home rose 15% in June. See page 3.

Plus, there is plenty of inflation in the pipeline. The PPI for finished goods rose 18.6% YOY in June. Core PPI increased 8.8%. The PPI for final demand rose 11.2% in June, up from 10.8% in May. These price gains in the PPI indicate consumers face more price increases ahead or businesses face more margin pressure. One or both of these trends are likely in coming months. See page 4.

The persuasive argument for a recession is directly linked to inflation because inflation has increased more than wages. See page 4. As a result, real wages are declining and so is purchasing power. The way to stall or reverse inflation is to raise interest rates, but that too, will hurt consumers through higher mortgage and loan rates. It will impact small businesses by weakening profit margins, making credit more expensive and in some cases unavailable. Unfortunately, the Fed allowed inflation to get too high before responding. The gap between inflation, now at 9.1% YOY, and fed funds, now at 1.75%, means the fed funds rate is 863 basis points below inflation, or the “neutral” level. The Fed’s forecasts show that they expect inflation to slowly decline in 2022 which would make this gap a bit smaller. But that may be wishful thinking.

While a weaker economy and therefore lower inflation is a possibility, it also means a recession is already here. We think there are signs of an imminent recession in recent retail sales data. Total retail and food service sales increased 8.4% YOY in June, which may sound like the consumer is strong and vibrant. However, once sales are adjusted for inflation, year-over-year real retail sales (measured in $1982-1984) have been negative for four consecutive months. See page 5. Negative year-over-year real retail sales have been highly correlated with recessions in the past.

Auto sales are a major part of retail sales, and though there was a pickup in June; the longer-term trend remains negative. Moreover, as interest rates and prices rise, we expect auto sales to remain sluggish in the second half of the year. Gas station sales have been a boost to retail sales, but these gains are due only to the high price of fuel and it is shutting out other areas of consumption. Housing is also weak. The National Association of Home Builders survey for July dropped from 67 to 55. Traffic of potential buyers fell from a weak reading of 48 in June to an even weaker reading of 37 in July. In sum, many areas of the economy are showing weakness and it may not all be factored into equities as yet.

Gail Dudack

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